Sunday, June 18, 2017

While it’s certainly no secret that the multi-family sector
has been on a roll over the past few years, there have been some recent signs
that its growth trajectory will continue to moderate this year.

Nonetheless, with an economic expansion in
its seventh year and an average of one million new renter households being
formed over the past five years, these economic tailwinds should continue to
support this sector over the near term.
The long-term prognosis is even better, with a recent study concluding a
need for 4.6 million new apartments between now and 2030.

For now, overall tenant demand remains strong, especially as
more millennials continue to form new households after being delayed due to the
Great Recession and paying off student loan debt. Nationally, the homeownership rate fell to a
51-year low of 63 percent last year, and is expected to remain around this
level for at least the rest of the year.

Construction of new apartments is also expected to peak this
year, especially as over-supply in some high-growth markets is beginning to
impact both vacancy rates and rent growth.
Mindful of this trend, construction lenders are also being more
discreet, critically assessing the experience of developers, double-checking
projected returns while acknowledging lower growth in operating income.

In addition, if government proposals for
increased infrastructure spending see the light of day, this could mean
increased competition for both the materials and labor required for more
multi-family supply.

According to recent figures from brokerage Marcus & Millichap,
most of the softening is beginning to occur for Class A buildings, both due to
an increase in new product as well as historically weak absorption during the
fourth quarter of 2016 being pushed into 2017.
Nationally, this meant a large bump in Class A vacancy rates to over 6.5
percent. Yet instead of lowering asking
rents to fill vacant units, many owners are betting that the strong spring and
summer leasing season will mop up the excess supply.

For Class B properties, a slight rise in vacancies was often
due to renters opting to make the leap to higher-quality apartments, especially
in regions such as the South where the price difference between the two classes
is the smallest. Not surprisingly, the vacancy
rate for Class C properties remains the lowest due to the strong demand for
affordable housing.

Both Axiometrics and Yardi Matrix -- which regularly survey
apartment communities across the country each month – have shown a similar
softening in both rent growth and occupancy rates. According to Axiometrics, although its
surveyed properties had rebounded to the benchmark occupancy rate of 95 percent
by May 2017, annual effective rent growth has stayed within a fairly narrow
band of 2.0 to 2.2 percent over the past six months.

Yardi Matrix, however, showed an annual overall rental rate
increase of 1.5 percent for the 12-month period ending in May 2017, down
sharply from the 5.3 percent noted a year ago even though it reported an
overall occupancy rate of 94.8 percent for April.

As Marcus & Millichap similarly found,
this is largely due to a temporary over-supply in Yardi’s “Lifestyle” class,
which caters to households who prefer to rent versus owning, and has resulted
in flat growth. Meanwhile, low supply
and strong demand for “Renter by Necessity” units helped propel their average
rents by 2.6 percent over the same time period.

Due to this softening, as well as higher borrowing costs and
proposed changes to fiscal policy and the tax code – including a possible end
to the popular 1031 tax exchange program – investors have recently pulled
back. Preliminary estimates for first
quarter 2017 sales suggest a decline of 15 to 20 percent from the same period
of 2016, although greater clarity on these policy changes would certainly lead
to a rebound in investor interest.

In the longer term, a combination of delayed marriages, an
aging population and continued legal immigration will continue to put
increasing pressure on new apartment supply, but it’s not just the millennials
filling these units. It’s also Baby
Boomers and other empty-nesters over 45 who accounted for over half of new
renter households over the last decade in search of the flexibility and
convenience of apartment living.

With an
annual projected demand of 325,000 new units per year through 2030 and an aging
housing stock increasingly in need of renovations, there should be very
favorable terms for well-financed investors, especially in high-cost and
high-growth areas throughout the West and the South.